• Costing and pricing

• . Costing By estimating the cost of production and the directly connected

overheads you set up the basis for developing your pricing policy and for
preparing the financial plan of your business. The cost of your business is
composed of four basic components that need to be briefly discussed in
your business plan. These are explained below. • Cost of product
development. This budget may include the costs of any fundamental
research, product development and design work as well as the costs of
producing and testing a prototype. Be sure to include labour, materials,
consulting fees, certification costs and the costs of professionals such as
attorneys. Development costs are relevant not only for companies making
products. Service businesses also incur costs in developing their services.
Consulting companies, for example, incur costs in developing
methodologies and tools, training their staff and preparing
documentation.
• Design and development costs expected in the future are often underestimated.
Also, the real costs of past development work are often neglected and not fully
included in the price of a product. When planning costs, also provide a
contingency plan for what will happen to costs if problems such as delays, a failure
to meet industry standards and mistakes occur. Such problems are common. In
many cases regulations allow for the costs of developing a product or a service to
be entered on the asset side of the balance sheet. In such a case those costs can
be treated as any other investment of the company (for example, the purchase of
machinery and equipment) and thus be depreciated over a period of time. The
depreciation period is dependent on the life cycle of the product developed as
well as on the tax regulations.
• Cost of goods. For a manufacturing company, the cost of goods is the cost
incurred in the production of the products. In such a case, the costs
included are those for materials, labour and overheads related specifically
to product manufacturing. You can work out the average "cost of goods"
for each product by adding all related costs mentioned above and dividing
by the number of products produced. This unit cost will be a useful
indicator in developing your pricing policy and assessing your
competitiveness. For a retail or wholesale business, the cost of goods
includes the purchase of inventory and associated costs such as
transportation and insurance. When working out the costs of your goods,
be alert in identifying any measure that can lower your costs. • Operating
expenses. To establish the total of your operating expenses, you add up all
the expenses incurred in running your business. Expense categories
include marketing, sales and overheads. Overheads include fixed
administrative expenses such as management and secretariat, which
remain constant regardless of how much business your company does.
Overheads also include variable expenses, such as travel expenses,
equipment leases, supply of electricity and office material supplies.
• Depreciation and interest on capital. This includes
the depreciation of the equipment and
infrastructure that are required in order to
operate your business. As mentioned earlier, part
or the whole of the development costs
(depending on the stance of the tax authorities)
can be entered on the asset side of the balance
sheet and then depreciated over a period of time.
The interest expense for any loans needed to
finance equipment or working capital is also
included in this category.
• Pricing When establishing your price policy, you
should examine two principal sets of questions: •
How sensitive are your target clients to price?
How does the price variation influence their
buying behaviour? Which spread of price levels is
acceptable to them? How would they react to
lower prices of comparable products from your
competitors (buyer's standpoint)? • Which price
covers your costs and leaves you a satisfactory
profit (seller's point of view)? When setting the
price of your products or services, a good balance
of these two considerations has to be found.
• Buyer's standpoint The buyer’s price acceptance
will depend upon three main factors: • Value. The
value that your product brings to your clients is
the primary factor determining the price they are
ready to pay. The examples below illustrate some
types of product values. Suppose you are selling a
specific electronic component to a supplier of
complete systems. This component part would be
of great value to your client if it forms a crucial
part for the operation of the entire system and if
his/her business is a profitable one.
• Competitive choices in the market place.
Although your product may be good value,
and although your clients can afford to pay
the price, you can be sure that they will buy it
from elsewhere if it is cheaper there. The
competitive choice in the market place is an
important mechanism that keeps prices under
control. Consequently, before fixing your own
prices you have to examine the products and
prices of your competitors.
• Seller's point of view From the seller's point of
view, there could be various policy options in
setting the price. Important options are
maximizing total profit, maximizing the
volume of sales or maximizing the margin per
unit sold.